Family companies under attack in divorce courts: Are you missing a trick?

An increasing number of substantial family companies and businesses come under the microscope in the divorce courts. Why are these companies being scrutinised more than ever? What steps can ultra-high net worth (UHNW) individuals and their advisers lawfully and responsibly take to protect family companies? And how can family and corporate/commercial lawyers collaborate to protect wealth from day one?

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Family companies ill-prepared for the risk of divorce

Successful family companies are often built over generations. For UHNW families, a company is often their most valuable and prized asset – one which they will seek to protect at all costs. But they do not always fully appreciate the financial risk a potential divorce or family dispute presents to their commercial, real estate and business interests.

More often than not, when complex and elaborate corporate and real estate structures are created, insufficient consideration is given to the potentially serious impact a divorce may have on that structure. When companies are scrutinised and come under attack in the divorce courts, the protection afforded by the corporate structure is not as watertight as many assume. And this often involves attacks on real estate.

Back to basics: Why do companies end up on the table?

On divorce, the court has the power to order a sale or transfer of shares in a company owned by a party. But, in certain circumstances, where appropriate, the family courts have gone far further.

In Prest v Petrodel Resources Limited & Others [2013] UKSC 34, [2013] 2 FLR 732, the Supreme Court considered the issue of when a court may take the assets of a company in order to satisfy the personal liability of another party. Or, to look at it another way, when the court may ‘pierce the corporate veil’.

The case involved a wealthy oil trader, Mr Prest, who, between 1995 and 2004, transferred seven valuable UK residential properties to a group of companies known as the Petrodel Group. The question for the Supreme Court was whether it could order the properties to be transferred to the wife, as part of the financial settlement on divorce, given that they legally belonged to the companies not Mr Prest.

The Supreme Court clarified that only in very exceptional circumstances will the court be able to ‘pierce the corporate veil’. However, it did not stop there. The Supreme Court went on to conclude that, on the facts and in particular the way in which the properties had been acquired, they were being held on resulting trust by the companies for the husband. The court subsequently ordered the companies to transfer the properties to the wife and, in doing so, fundamentally changed the way family courts could approach the issue.

The significance of this decision – particularly to those with corporate interests – cannot be underplayed. In the right circumstances, the family courts now have a clear line of attack. This potentially affects anyone seeking to protect personal assets by placing them in a corporate structure. Increasingly, we are likely to see courts lifting (as opposed to ‘piercing’) the corporate veil. Courts will look at the reality of the situation when it appears that assets may have been transferred to a company in order to conceal their true ownership: ‘who is the beneficial owner of the asset?’ will be the key question.

And there’s more…

The court has the power to vary what are known as nuptial settlements. Perhaps surprisingly, there is no statutory definition of what constitutes a ‘nuptial’ settlement. In this context, the reference to ‘settlement’ is perhaps slightly misleading, as it does not apply exclusively to conventional trust settlements/arrangements. Indeed, as the law currently stands, its scope is much broader than that.

The leading modern case on the meaning of nuptial settlements, Brooks v Brooks [1995] 3 All ER 257, [1995] 2 FLR 13, a BLP (Paisner & Co) case in which we acted for the successful wife, provides a useful starting point. In that case, the House of Lords (as it then was) treated a private pension fund as a nuptial, and therefore variable, settlement. Lord Nicholls suggested a nuptial settlement would be one which makes ‘some form of continuing provision for both or either of the parties to a marriage, with or without provision for their children’. Clearly, a very broad definition and one which, importantly, in appropriate circumstances, may allow a judge to find that a family company or corporate structure is a nuptial settlement.

Given the court’s broad and ‘unfettered discretion’ when deciding how to vary a nuptial settlement, there are potentially significant ramifications for those involved with substantial family companies.

Two recent cases amply illustrate the court’s often robust approach to this issue…

1st Cautionary tale: When a family company becomes a variable nuptial settlement

In DR v GR and Others (Financial Remedy: Variation of Overseas Trust) [2013] EWHC 1196 (Fam), [2013] 2 FLR 1534 the wife applied for the variation of a settlement involving a discretionary Jersey trust. The trust owned a Liberian company, which in turn owned a UK company, which in turn owned two further companies. It was argued, on behalf of the companies, that the judge (Mostyn J) was unable to order anything other than a transfer of the shareholdings in the Liberian company and could not deal with the assets at the bottom of the settlement.

The judge disagreed. He charged assets held by the companies in favour of the wife and removed her as a director of the companies. In doing so, he commented:

‘A family company which under an arrangement makes some form of continuing provision for both or either of the parties to a marriage is capable of itself of amounting to a variable nuptial settlement whether or not the company is owned by a trust of which the spouses are formal beneficiaries.’

He went on to say that if ‘some form of continuing provision for both or either of the parties to a marriage’ has been made, ‘which would include, on the authorities, the provision of accommodation ... from assets held by a group of family companies then the entire set-up, when viewed as a whole, is capable of amounting to a variable nuptial settlement’.

This puts companies firmly under the family law spotlight.

2nd Cautionary tale: Resulting trust… and possibly leave the door open for a variation

More recently, the court was invited to consider a similar issue in Chai v Peng & Others [2017] EWHC 792 (Fam) – a case involving the Chairman of Laura Ashley, Dr Khoo Kay Peng, and his ex-wife and former Miss Malaysia, Pauline Chai.

Among numerous other issues, the case involved UK real estate worth £18m held in a complex family company structure, which was ultimately owned by the husband. Applying the decision and principles in Prest, the court found that the companies within the structure held the estate on resulting trust for the husband and was capable of being transferred to the wife as part of her overall award.

But it went even further…

The wife had also applied to vary the company structure as a nuptial settlement. Having found the estate was held on resulting trust (and therefore capable of being transferred to the wife), the judge (Bodey J) did not have to deal with the wife’s variation application. However, he still chose to as a precaution in case he was found to be wrong on the resulting trust point.

In doing so, the judge decided hypothetically that the overlying structure itself would not be variable, as this would, in his view, have deprived the companies of their property and paid insufficient regard to the decision in Prest. But he concluded that the provision of accommodation (which in this case was via a notional licence to occupy) would be, if necessary, capable of variation in order to provide the wife with accommodation during her lifetime. In addition, the judge adjourned and left open the wife’s variation application as security in the event the husband did not comply with the court’s lump sum order. In doing so, the judge commented:

‘The wife may restore that application with a view to trying to achieve income provision, by way of variation of settlement, to replace some of what she would have lost by virtue of the husband not complying in full with my proposed order.’

Again, this has potentially serious implications. Effectively, the judge expressed a view that, if necessary, and despite the fact that the overlying corporate structure would remain unvaried, the court still had the power to treat the companies holding the real estate as a variable nuptial settlement to produce an income for the wife in the future.

So, what’s the trick?

In short, a seamless approach and responsible asset protection planning.

The law in this area, particularly whether companies are variable as nuptial settlements, is currently in a state of flux. Opinion is divided amongst both the judiciary and lawyers. However, the potential financial risk and exposure to family companies in the event of a divorce is both real and obvious. While the law remains unclear, there is even more need for UHNW families and both their private client and corporate advisers to be alive to these risks.

Note the following two key pieces of advice for an UNHW family looking to structure, operate and manage a risk-resilient company:

1. Foster legal teamwork

Most important is the need for private client/family and corporate/commercial lawyers to work collaboratively. Whether it’s held through complex company structures or not – wealth is wealth whatever wrapper it comes in. It is important advisers work together seamlessly when advising clients who are creating new (or restructuring existing) companies.

Care will need to be taken to ensure companies are structured, operated and managed in such a way so as to ensure they do not become ‘nuptialised’. As highlighted, a failure to do so may leave a family company exposed to direct variation by the court in the event of a divorce. For any substantial company, the financial and practical implications of that could be profound.

Similarly, advisers will need to exercise caution when families are acquiring assets within any corporate structure. In particular, there will need to be the necessary documentation and a clear paper trail which, if necessary, could be presented to the divorce courts as evidence that those assets are not merely being held on trust for a husband or wife, and the husband or wife are not the true beneficial owners.

2. Compliment a company with a meticulous pre or postnuptial agreement (PNA)

The first point also highlights the advantages that may be afforded with a carefully crafted pre or postnuptial agreement. When advising UHNW individuals and families, it will be important to consider how a well-timed PNA can be used to further protect company interests. Company shareholdings, capital accrued through dividends and business income can all potentially be ring-fenced within a PNA.

This is all part of responsible asset protection planning. The right thing to do.